Why Lumen Technologies has sunk today

Actions of Lumen Technologies (LIGHT -10.29%) were down sharply on Tuesday, down 9.1% at 2:23 PM EDT.

Lumen is a debt-ridden company whose stock struggled earlier this year. However, an early-year deal to extend its debt maturities, combined with long-term deals for AI (artificial intelligence) networks, sent the stock soaring in early August.

But a few weeks after the big boom in stocks, skeptics are publicly throwing cold water on the prospects for an AI-fueled recovery. Today, another short seller expressed skepticism about how meaningful those AI trades will really be in addressing the company’s massive debt load. This was the second short seller to post a note in just the past week. This added to the overall market fears today, which resulted in a big drop.

Hedgeye expresses concern about Lumen’s debt and cash flow

On Tuesday, stock recommendation firm Hedgeye published a note advising readers to short Lumen. The note reflected familiar concerns about Lumen’s debt load and declining financial values. Specifically, Hedgeye pointed to Lumen’s high debt-to-EBITDA (earnings before interest, taxes, depreciation and amortization) ratio of 4.3, along with “limited” free cash flow generation. While noting that the company’s agreement to push its debt maturities to 2029 gives management more time for a turnaround, the short seller expressed skepticism that Lumen’s declining core business will change over time.

Hedgeye’s short note comes just a week after another short seller published a report on Lumen in late August that expressed similar concerns.

Short sellers posited that Lumen disclosed $5 billion in new AI deals and another $7 billion in additional AI “opportunities” just a day before releasing second-quarter results to document the deterioration continue.

In Q2, Lumen’s business continued to decline, with revenue down 10.7%. Management noted that about 36 percent of that decline was related to divestitures, but the overall business still shows a single-digit decline. Management also highlighted two areas of focus, its enterprise “growth” portfolio, which grew 1.5% year-over-year, and its fiber-to-the-home consumer product, which grew 14.6%.

The problem is that those growth segments are still a minority of the business, while the majority of Lumen’s product revenue continues to deteriorate. Lumen also posted free cash flow of $156 million loss in the quarter. And while management has guided for $1.1 billion in positive free cash flow this year, $700 million of that will be due to a one-time tax refund.

Of note, Lumen has about $18.9 billion in debt and pensions.

Investors should be skeptical of an AI rally

Investors could look at Lumen as a value stock given that it has been trading at a difficult valuation, but could also benefit from rising AI network spending. However, we should remain cautious. The new $5 billion AI-related Private Connectivity Fabric business will take place over three to four years, according to the company’s quarterly report, and will also involve additional spending by Lumen. That’s about $1.25 billion in revenue per year, with uncertain profitability.

This compares to the $13.7 billion in revenue made by Lumen over the past 12 months. But these kinds of “new” revenue streams have to replace older technologies that are still declining, so it’s not like Lumen is going to increase its top line by 10% just as a result of this deal.

The bottom line is that Lumen’s turnaround is far from assured, even with its shiny new AI revenues. Therefore, investors should be skeptical and read the reports of short sellers before considering an investment.